Your Net Worth Is In Jeopardy! by Chuck Whitman

The gains that you have reaped in the last few years are vulnerable to the market taking them all back.

You have been feeling great about your financial progress in the last few years. The memories of your portfolio getting smashed in the COVID Crash and your financial stress has finally been fading away.

However, in 2022, it all comes back like one big adrenaline rush. You feel overwhelming fear as you realize you should have been more diligent in managing your risk. As a result, you oscillate between feeling numb, stuck, scared, and exhausted because you can’t believe you let this happen again.

You find yourself stress eating, skipping workouts, and drinking in the evening because you want to escape the mess you put yourself in. Your energy collapses, and you find yourself sick because your body caves under all the stress.

The stress has caused you to lose your connection to God. You can’t hear Him anymore because there is too much chatter in your head. You felt grounded and confident. You now feel weak and alone.

Your spouse is furious because your retirement plans have now been suspended indefinitely. Your dream trip to Europe has to wait. Who would think your greatest ally has now turned into your greatest adversary, and they live under your roof!

Lastly, not only did your portfolio get smashed, but now you are facing job loss as your company’s financial fortunes have turned rapidly in an economy that is falling apart. You didn’t realize that you were so leveraged and correlated between your investment portfolio and your business.

WOW!

We all know that humans live in greed and fear, but we often never see it in ourselves. As great investors/traders, plans to be prepared for different scenarios are critical to act objectively in the face of inevitable adversity.

“Be fearful when others are greedy and greedy when others are fearful” – Warren Buffett.

Currently, we are in an environment where people are being greedy. Everyone wants to buy the next CryptoCurrency or the next Meme Stock. The focus is on how much money they will make this year. Recency bias is in action. Everyone is counting on the recent trends to continue because this is their path to riches.

Van constantly preaches to understand your Market Type. I call it Market Environment. Profits are more accessible when we trade in alignment with the Market Type.

The environment in the last 18 months is where people have made record profits in their portfolios. Let’s examine why:

Problems in the economy started to emerge before COVID. On September 17, 2019, the United States Repo (Repurchase Agreements) Market had a liquidity shock. This shock was in response to a combination of the Fed removing money from the monetary system and new banking regulations. We can see starting at that point; the Fed began to put money back into the system. Of course, the significant policy change came in response to COVID-19. In March 2020, the Federal Reserve and other global central banks began the most extensive monetary intervention in history. This intervention has continued since. The result is unprecedented money supply expansion. At the same time, Governments around the world (led by the United States) initiated massive fiscal policies that also inserted large amounts of money into the economy.

You can see the result through two charts listed below:

In this chart, we see the growth in M1 Supply. M1 Supply grew by over 500% in less than two years. In other words, 80% of all dollars were created in the last two years!

Federal Reserve Balance Sheet increased by 5 trillion dollars in the last two years. For perspective, the Fed Balance sheet only increased by $1.5T during the Great Financial Crisis.

When the Federal Reserve increases its balance sheet, they create money and inject it into the economy by buying government bonds. The Fed has been on a massive bond-buying program since March 2020.

Where did all this money go? Some of it went directly to citizens through stimulus payments. Some went to government programs designed to provide health care (vaccines, tests, etc.). However, in an incredibly uncertain environment, most of the money stayed in the financial system to buy financial assets. Investors used the money to buy stocks, bonds, cryptocurrencies, artwork, and real estate. Investors didn’t use the money to build new factories or fund new research projects. The result is that financial assets have exploded. The rich got richer in this environment. The divide between rich and poor widened.

When you look at your portfolio, it is crucial to understand that your profits are coming from all the money deployed into the system. Remember the famous adage, “Don’t confuse genius with a bull market!” The current environment is an outlier of historic liquidity infusions.

Understanding this concept is important because it gives us a framework to manage our risk.

In the headline, I said your “Net Worth is in Jeopardy!” There has been a significant shift in the investing environment. In December, the Federal Reserve signaled to shift from liquidity provision to neutral. The Fed is cutting back bond purchases every month with the target of ending purchases after March 2022. In addition, the expectation is for the Fed to raise interest rates three times in 2022.

When the Fed starts tightening via interest rate increases and suspending bond purchases, the market can continue higher for six months or even a year after this happens. Why?

There’s a reason for this because there’s a psychological effect that’s going on, people are making money, and they don’t want it to stop. So they go into denial that things could change. They look for answers; they look for feedback that validates their beliefs, rather than being willing to change their beliefs. If they’re making money, because things are going up, they will look for reasons to stay long.

The problem is when the environment shifts and the inevitable reversal comes, it will turn on a dime, and it will be too late. It will be bigger and faster than you can imagine.

What do we do?

You review every position in your portfolio. If every position in your portfolio went down 33% in a month, how much would you lose? How would you feel if that happened? If it makes you sick to your stomach, you have too much risk. Lower that number to a loss you can handle. Put a plan in place for each of your investments. What is the scenario where you need to take action?

Lastly, I am a HUGE believer in the use of options. If we understand how to use options in an environment like this, we can limit our risk. Then when the inevitable moment comes, whether it’s next month, six months, or a year from now, we know how much we can lose, and we can limit the damage in our portfolio. If we’re able to limit the damage to our net worth, that will put us in a position to respond opportunistically later on, which I’ll talk about down the road. But right now, my goal is to make sure that you are safe. That’s what I want for you.

Go back to the scenario you envisioned. By taking action to limit risk in your portfolio and using options to help you do so, imagine how your life will look. Instead of stress, you will gain confidence knowing you took action and kept your profits. Instead of chatter and fear inside your head, you can be clear to focus on your connection with God. Instead of your spouse being furious with you, they will have a whole new level of trust and respect because you protected them, you protected your plans together, and you protected your future. No matter what comes your way at work, you can respond to great opportunities because you operate from a firm foundation.

Taking action to protect yourself can have a positive impact beyond this year. It can impact your future for years to come because you positioned yourself in strength instead of fear.

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